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(^16) Financial Management
All these decisions interact, investment decision cannot be taken without taking the
financing decision, working capital decision also needs financing, dividend decision is a
payout mechanism and has to be taken care of from financing. These tasks are divided
and are taken care of by various entities.
Objectives of Financial Management
To make wise decisions a clear understanding of the objectives which are sought to
be achieved in necessary. The objectives provide a framework for optimum financial
decision-making. In other words, they are concerned with designing a method of
operating the internal investment and financing of a firm. We discuss in this section the
alternative approaches in financial literature. There are two widely-discussed approaches:
(i) Profit maximisation approach and (ii) Wealth maximisation approach.
It should be noted at the outset that the term ëobjectiveí is used in the sense of a goal
or decision criterion for the three decisions involved in financial management. It
implies that what is relevant is not the overall objective or goal of a business but an
operationally useful criterion by which to judge a specific set of mutually interrelated
business decisions, namely, investment, financing and dividend policy. The second point
that should be clearly understood to that the term objectives provides a normative
framework. That is the focus in financial literature is on what a firm should try to
achieve and on policies that should be followed if certain goals are to be achieve. The
implication is that these are not necessarily followed by firms in actual practice. They
are rather employed to serve as a basis for theoretical analysis and do not reflect
contemporary empirical industry practices. Thus, the term is used in a rather narrow
sense of what a firm should attempt to achieve with its investment, financing and
dividend policy decisions.
Profit Maximisation Decision Ceriterion
According to this approach, actions that increase profits should be undertaken and
those that decrease profits are to be avoided. In specific operational terms, as applicable
to financial management, the profit maximisation criterion implies that the investment,
financing and dividend policy decisions of a firm should be oriented to the maximisation
of profits.
The term ëprofití can be used in two senses. As a owner-oriented concept it refers
to the amount and share of national income which is paid to the owners of business,
that is, those who supply equity capital. As a variant it is described as profitability. It
is an operational concepts and signifies economic efficiency. In other words, profitability
refers to a situation where output exceeds input, that is, the value created by the use
of resources is more than the total of the input resources. Used in this sense, profitability
maximisation would imply that a firm should be guided in financial decision making by
one test; select assets, projects and decisions which are profitable and reject those
which are not. In the current financial literature, there is a general agreement that profit
maximisation is used in the second sense.
The rationale & behind profitability maximisation, as a guide to financial decision
making, is simple. Profit is a test of economic efficiency. It provides the yardstick by